Agustino Fontevecchia
, ContributorFrom global billionaires to art market fraud, I cover power and moneyOpinions expressed by Forbes Contributors are their own.

Investors could get crushed if Treasury yields unhinge

U.S. Treasury yields fell to an ominous all-time low on Wednesday, as fearful investors crammed, once again, into the perceived safety of U.S. government debt. Rates on benchmark 10-years dropped to 1.6190%, on fears over a European implosion, a hard landing in China, and slowing momentum in the U.S.

This unprecedented fall should be an indication to investors that Treasuries have entered dangerous territory. The overcrowded trade will face a reversal, which could cost investors dearly, even more than a possible Eurozone breakup.

Bond yields across the globe dropped to record lows on Wednesday. Beyond the U.S., German bunds and U.K. 10-year gilts fell to record lows too, while yields on Spanish and Italian debt rose. An interesting piece on Business Insider notes that Finnish, Swedish, Australian, Canadian, Japanese, and Swiss yields fell to historical bottoms as well.

Markets are clearly afraid. They’re afraid of a Greek Eurozone exit, afraid of an insolvent Spanish banking sector bringing monetary union down, afraid of contagion coming to Italy. Furthermore, China is slowing, but the PBoC has denied it is considering further stimulus or rate cuts in the near term, and investors in the U.S. are wary of another possible disappointing jobs report on Friday.

The problem is that investors are jumping head first into the supposed safety of Treasuries, but this has done nothing more than raise the risk of holding those securities by the same proportion.

Regardless of the reason for the fall, Wednesday’s record lows constitute a “flight to liabilities” rather than a flight to safety, as the coming correction in Treasury yields will be unprecedented, “potentially many times costlier than a Greek default,” according to Ashmore Investment’s Jan Dehn. The risk of a reversal is huge, and investors stand to lose more than 30% when yields move back to historical levels, the investment manager argued.

Unprecedented money printing, zero interest rate policy, and quantitative easing (in different degrees) by the Federal Reserve under Bernanke, the Bank of England, Bank of Japan, and the ECB have pushed yields to historical lows in highly indebted countries (like the U.S., the U.K., Germany, and Japan).

When the Fed begins its exit strategy, the flood doors will be opened, but only a trickle of water will be able to come out: “Liquidity depends on the existence of both buyers and sellers. If [U.S., U.K., European, and Japanese] bond yields unhinge much more paper has to exit via a smaller door,” explained Dehn.

Historically, U.S. 10-year Treasuries have traded between 6% and 7%, which meant that a correction from just below 1.8% would result in losses in excess of 34%, according to Dehn’s calculations. If Dehn’s right, PIMCO’s Bill Gross was shorting Treasuries way ahead of time.

Yields will begin to rise, markets indicate. While Bernanke and the Fed expect to keep the zero-rate policy until late-2014, three members of the FOMC indicated policy firming should start this year, while another three expect it in 2013. Ashmore Investment’s forecasts suggest 10-years will yield 2.25% by the end of the year, and continue to ascend gradually thereon.

This could have nefarious effects on banks’ balance sheets. As Peter Schiff told me previously, while banks like JPMorgan Chase, Wells Fargo, and Bank of America passed the Fed’s strenuous stress tests, they weren’t tested for a big drop in the bond market, which they “would fail.” If everybody scrambles for the exit at the same time, the downfall would be exacerbated while liquidity could possibly dry up.

The apparent safety of Treasuries is questionable. Markets are about perception and capital flows, and as long as those favor U.S. debt, then investors will be safe parking their money there. Eventually, the Fed and other central banks will have to unwind monetary easing, at least that’s what they’ve told us. When this begins to happen, investors could be crushed by a wave that will look a lot like a Tsunami, they’d be better suited if they got out of the way in time.